Interest is Halal?

Halal Interest. Oxymoron? How about Muslim Commercial Bank? Few things in Islam draw such consensus from Ulema as the condemnation of Interest. Yet there is no escape from its use in modern day economies. I think that the use of interest today is in line with the basic principles of fairness and is, therefore, not Haram.

Legal and economic consequences of using interest as a business and finance tool are very different today than they were in the sixth century. The efforts to eliminate interest from capitalist and its variant economies to make them more Islamic provide nothing more then some comic relief as the mullahs and their ilk explain the right way to run businesses, economies and banks.

The Landlords in Pakistan lend money, interest free, to Haris in rural areas knowing that they will not be able to pay back. This is a tool for the Landlords to exploit the Haris. The money they lend serves as a bond to keep the Haris from leaving that Landlord. Since the Hari cannot pay back the loan he cannot leave the Landlord. That I think is very HARAM – albeit interest free.

Other then the fixed rate that the borrower has to pay on principal, Interest that was prohibited by Islam does not have much in common with the Interest that is used today. The economic, market and legal principles that govern use of interest today eliminate the exploitation of borrower that was the concern in the old days.

The interest in old days had the following characteristics:

- Fixed rate determined by lender or group of lenders (little or no market pressure and no Government intervention)

- Contractual agreement was the wish of the lender

- Liability of the borrower was unlimited. It was basically a bond on the life of the borrower and his present and future generations. A borrower could end up becoming a slave of the lender or selling his children

- Borrowers could borrow more money then they could afford to pay back

- Lender could use the money to control the lives of the borrower as they made concessions or demands of payment to control the behavior of the borrowers

- A lender could become a monopoly and restrict and control the natural evolution of market, economy or even civilization

The interest today has following characteristics:

- Fixed rate determined largely by Government and free markets (democratic?)

- Contractual agreement governed by the laws of the state and Federal Government that are subject to change with new interpretations of the constitution to keep the system fair

- Limited liability of the borrower. Organizations and Institutions go out of business and file for Bankruptcy and sometime leave the lenders to take losses. During the downturn in real estate markets borrowers walked away from their houses as the value of their houses plummeted and their equity evaporated.

- Lending is based on lien on the property or credit rating. Borrowers ability to borrow more than they can afford is limited. Unless they attempt to cheat the system.

- Lending institutions are closely monitored and regulated and have to abide by the Antitrust laws

Although it is not an exhaustive list of differences, it does highlight the fact that the consequences of using interest in its modern form are very different from what they were in the old days. And it is clear to me that the interest that was forbidden is not the same as the one that I pay on my mortgage, Ulemas and Fatwas notwithstanding. There are those who believe all Islamic injunctions to be timeless - I prefer to keep my mind open and go by the spirit rather then the letter of the law.

During Zia-ul-Haq’s time Islamic Banking was introduced. Under this type of Islamic loan the interest was added to the total principal that was loaned to the borrowers. The contract was drawn for repayment of the entire amount (principal + Interest). Many Ulemas consider this to be Islamic (Of course there are those who disagree). This is nothing but an interest based loan with a legal cap on accrual of interest and non payment penalty.

Any discussion of Interest prompts the use of risk/return only alternatives to Interest. Some people extol the virtues of venture capital as a model of Islamic financing and argue that its success in modern economy is a proof that it can replace existing financial system and can eliminate use of interest. This notion, however, is not true. The venture capital is only one of the many sources of raising capital in the modern economies. The venture capitalists invest in companies that use debt as part of their capital structure. A pure long-term sustainable risk/return based investment model does not exist in the modern capitalist economies. Such system would limit the choices of the investors to claims on the earnings. This may not be acceptable to those who want to limit their risk or those who want to invest for much shorter than the earnings estimation periods.

The companies today use Interest not only as a source of capital but also as a tool to magnify their earnings and reduce their taxes. An appropriate debt/equity ratio that is in line with the respective industry is essential for running good business. The way interest is used in modern economies can hardly be considered an evil. It is the life and blood of modern economies.